United Parcel Service, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet figures are as of March 31, 2018. Comparisons are with Q1 2017 unless stated otherwise. Figures are in U.S. dollars.
Business context and results
UPS operates U.S. Domestic Package, International Package, and Supply Chain & Freight businesses. Management reported solid results internationally and in Supply Chain & Freight, while U.S. Domestic Package performance was pressured by weather, expanded Saturday operations, higher pension costs, and investments in facilities and technology.
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $17.113 billion | $15.510 billion | +10.3% |
| Operating expenses | $15.593 billion | $13.893 billion | +12.2% |
| Operating profit | $1.520 billion | $1.617 billion | -6.0% |
| Operating margin | 8.9% | 10.4% | -1.5 percentage points |
| Net income | $1.345 billion | $1.166 billion | +15.4% |
| Diluted EPS | $1.55 | $1.33 | +16.5% |
| Operating cash flow | $4.067 billion | $239 million | Increased $3.828 billion |
| Capital expenditures | $1.537 billion | $938 million | +63.9% |
Average daily package volume rose 4.6%, and average revenue per piece increased 4.3% to $10.97. Net income and EPS benefited substantially from a lower effective tax rate, not from higher operating profit: the effective rate was 19.0%, versus 31.8% a year earlier, primarily reflecting the Tax Cuts and Jobs Act and other favorable tax items.
Segments and material changes
- U.S. Domestic Package: Revenue increased 7.2% to $10.227 billion, but operating profit fell 20.4% to $756 million and margin declined to 7.4% from 10.0%. Management cited adverse weather, higher labor and pension costs, greater purchased transportation and fuel expense, and ongoing network and capacity investments. Weather and higher purchased transportation costs together reduced quarterly operating profit by approximately $85 million; lower pension discount rates added about $55 million of employee benefit costs.
- International Package: Revenue rose 14.9% to $3.533 billion and operating profit increased 14.7% to $594 million; margin was 16.8%, compared with 16.9%. Export volume growth, pricing, fuel surcharges, and currency supported results. Currency contributed $22 million to operating profit.
- Supply Chain & Freight: Revenue grew 15.6% to $3.353 billion and operating profit increased 14.1% to $170 million; margin remained 5.1%. Forwarding growth reflected higher truckload brokerage volume and stronger air-freight demand and pricing, alongside higher third-party transportation costs.
Comparability is affected by UPS’s 2018 adoption of the new revenue-recognition standard, applied retrospectively. For certain Supply Chain & Freight activities, UPS now reports revenue and associated purchased transportation costs gross rather than net. The 2017 comparison was recast; reported revenue growth therefore should be considered in light of this presentation change.
Cash, debt, liquidity, and capital returns
- Cash and cash equivalents were $3.544 billion; marketable securities were $665 million. Together they totaled $4.209 billion. Cash, cash equivalents, and restricted cash were $3.826 billion.
- Total debt carrying value was $23.092 billion, including $2.683 billion of current maturities and $20.409 billion of long-term debt. Debt was $24.289 billion at December 31, 2017. UPS reported no borrowings under its $4.5 billion and $3.0 billion revolving credit facilities and said it was in compliance with debt covenants.
- Operating cash flow was unusually high relative to Q1 2017, principally because Q1 2017 included $2.291 billion of discretionary pension contributions that were not repeated, and Q1 2018 benefited from income-tax cash receipts related to the timing of a December 2017 pension contribution. Thus, the year-over-year cash-flow comparison is not solely indicative of operating improvement.
- Investing activities used $1.446 billion, including $1.537 billion of capital expenditures. Financing activities used $2.550 billion, including $754 million in dividends and $261 million of share repurchases as reported in the cash-flow statement. The company declared a quarterly dividend of $0.91 per share and anticipated approximately $1.0 billion of share repurchases in 2018.
- Management stated that cash, operating cash generation, debt-market access, and other financing sources should be adequate to fund operations, planned capital spending, dividends, repurchases, and debt payments over the next several fiscal years.
Outlook, risks, contingencies, and unusual items
- UPS expected 2018 capital expenditures of approximately $6.5–$7.0 billion. The filing does not provide a clear full-year revenue, operating-profit, or EPS forecast.
- On April 25, 2018, UPS announced a phased voluntary retirement offer for certain retirement-eligible U.S. management employees, intended to reduce headcount and ongoing operating expense. This was a subsequent event after quarter-end.
- Approximately 280,000 employees were covered by Teamsters agreements running through July 31, 2018. UPS was also negotiating with airline mechanics represented by Teamsters Local 2727; that agreement had become amendable in 2013.
- Contingencies include a New York cigarette-delivery case in which a court awarded $9.4 million in damages and $237.6 million in penalties. UPS appealed; the company estimated potential losses of up to $247 million plus interest but could not estimate the likely amount. The $9.4 million damages award was accrued.
- Spain’s competition authority imposed a €19.2 million fine in March 2018; UPS intended to seek suspension and appeal. A Turkish competition investigation and a U.S. DOJ inquiry into USPS international mail transportation contracts were ongoing; UPS said it could not estimate possible losses for these matters.
- The Central States Pension Fund has projected possible insolvency in 2025. If UPS had to provide coordinating benefits to the UPS Transfer Group, the company estimated its projected benefit obligation could increase by approximately $4 billion. UPS had recognized no additional liability, citing significant uncertainty and its legal position.
- The filing identifies fuel prices, foreign exchange and interest rates, competition, security and technology disruptions, labor negotiations, pension and health-benefit costs, litigation, and regulatory and tax changes among risks. UPS reported no material change to the risk factors in its 2017 Form 10-K.
- Accounting and tax items: UPS early-adopted a standard allowing $735 million of Tax Act-related tax effects to be reclassified from accumulated other comprehensive loss to retained earnings. This changed equity presentation, not reported net income. The company also noted that the forthcoming lease standard was expected to materially change its balance sheet; it disclosed $1.637 billion of future minimum operating lease commitments at December 31, 2017.
Important facts for investors to verify
- Whether U.S. Domestic Package margins recover as weather impacts ease and facility, technology, and Saturday-operation investments begin to deliver benefits.
- How much of Q1 operating cash flow reflects recurring operations versus pension-contribution timing, tax receipts, working capital, and hedge-margin movements.
- Progress against the $6.5–$7.0 billion capital-spending plan and the expected approximately $1.0 billion of 2018 share repurchases while maintaining debt and dividend commitments.
- Developments in the Teamsters contract negotiations, the Central States pension exposure, and the New York, Spain, Turkey, and DOJ matters.
- The effects of revenue-recognition gross presentation, Tax Act accounting estimates, and lease-standard adoption on comparability, earnings, and the balance sheet.